“Unless we can make the philosophic foundations of a free society once more a living intellectual issue,
and its implementation a task which challenges the ingenuity and imagination of our liveliest minds, the prospects of freedom are indeed dark. But if we can regain that
belief in the power of ideas which was the mark of liberalism at its best, the battle is not lost . . .” – F.A. Hayek

2008

Hayek vs. The Development Experts

October
23, 2008

ABOUT AUTHORS

William Easterly is professor of economics
at New York University and co-director of NYUs Development
Research Institute. He is also a research associate of the
National Bureau of Economic Research, a non-resident fellow
of the Brookings Institution and the Center for Global Development,
and Co-Editor of the Journal of Development Economics. After
sixteen years as a World Bank economist, Easterly authored
The Elusive Quest for Growth: Economists Adventures
and Misadventures in the Tropics (2001), in which he
offers a devastating critique of international efforts to
spur third world development. Easterly elaborates on that
theme in The White Mans Burden: Why the Wests
Efforts to Aid the Rest Have Done So Much Ill and So Little
Good (2006). He holds a Ph.D. in economics from MIT.

Mary Anastasia OGrady is a member of The
Wall Street Journal editorial board and editor of Americas,
a weekly column appearing there that deals with politics,
economics and business in Latin America and Canada. She
is a recipient of the Inter American Press Associations
Daily Gleaner Award for editorial commentary and the Bastiat
Prize for journalism. Prior to joining The Wall Street
Journal in 1995, she was an options strategist for Advest,
Thomson McKinnon Securities, and then Merrill Lynch, where
she worked for 10 years. She holds a B.A. in English from
Assumption College and an M.B.A. in financial management
from Pace University.

-------------------------------------------------------

INTRODUCTION

by Mary Anastasia OGrady

The Hayek Prize is a new Manhattan Institute prize that
honors the book published within the past two years that
best reflects Frederick Von Hayeks vision of economic
and individual liberty. This year there were some thirty
books nominated. The purpose of the award is to recognize
the long-running influence of the Road to Serfdom
and to encourage other scholars to follow Hayeks example.

The winner of this years Hayek Prize certainly fits
the bill.

Hayek did not write much about foreign aid. But he did
have a lot to say about central planning, which, of course,
is the architecture of almost all government foreign-aid
programs in the postwar period. By definition, the do-gooders
in places like Washington and Geneva spend their days planning
the lives of the poor. And Hayek was prescient about where
such planning was bound to lead, perhaps because he had
observed British efforts in the colonies.

In the Road to Serfdom, published in 1944, he wrote:
The experience in the colonial sphere of Great Britain,
as much as any other, has amply shown that even the mild
forms of planning, which Englishmen know as colonial developments,
involve, whether they wish it or not, the imposition of
certain values and ideals on those who they try to assist.
It is, indeed, this experience, which has made even the
most internationally minded of colonial experts so very
skeptical of the practicability of an international
administration of colonies.

And Hayek wrote further in the same chapter: It is
fairly certain that in a planned international system, the
wealthier and therefore most powerful nations would, to
a very much greater degree than in a free economy, become
the object of hatred and envy of the poorer ones; and the
latter, rightly or wrongly, would all be convinced that
their position could be improved much more quickly if they
were only free to do as they wished.

Those words were written in 1944. More than sixty years
later and after $2.3 trillion in multilateral investmentas
the World Bank likes to call itthey are truer than
they were back then.

Take a look at Africa and Latin America, and it is hard
to avoid the conclusion that the most well-intentioned efforts
of the rich world have been an unmitigated disaster.

But who has been able to speak such heresy? Those outside
the world of foreign aid are accused of not knowing enough
or not caring enough. Those inside the system have all the
wrong incentives. For most, it is not just their jobs that
depend on the status quo, it is their careers.

That was until William Easterly decided to break a few
rice bowls. He is being recognized here tonight for The
White Mans Burden: Why the Wests Efforts to
Aid the Rest Have Done So Much Ill and So Little Good.

William Easterly is a professor of economics at New York
University and co-director of NYUs Development Research
Institute. He is also a research associate of the National
Bureau of Economic Research.

But his most important credentialand the one that
doubtless makes the aid brigades cringeis the fact
that he spent sixteen years as an economist at the World
Bank. In that role, he not only had a first-person encounter
with how aid was designed, he also had a hard time not noticing
that the results were, shall we say, suboptimal.

He has made the devastating observation that the central-planning
model is a big part of the problem. Rather than looking
for bottom-up solutions to problemsthe way the market
would, the way that searchers dointernational
aid imposes its solutions from the top down. And therein
lies the fatal flaw.

In The White Mans Burden, William Easterly
has brought together knowledge and courage to speak about
what he saw first-hand, what he knows as an economist, and
what no one who looks at the result of the past sixty years
can deny. This is why he so deserves the 2008 Hayek Prize.

-------------------------------------------------------

HAYEK VS. THE DEVELOPMENT EXPERTS

by William Easterly

Tonight we find ourselves in a moment similar to that in
which Hayek wrote The Road to Serfdom in 1943. Then,
as now, a great financial crash was seen as a failure of
freedom. Actually, things were even worse then for Hayeks
point of view. In the aftermath of the Depression, many
pointed out the apparent success of centrally planned industrialization
in the Soviet Union in outperforming markets. As Hayek wrote
in 1943, democracy barely existed outside of a few English-speaking
societies. Even in the U.S., people noted the apparent success
of government top-down planning for wartime production of
arms. Under these circumstances, Hayek knew he would be
caricatured as a right-wing ideologue, even though his ideas
did not fit into the stale partisan debate about markets
versus government. He argued that the best system in the
long run relied upon the creativity of individuals at the
bottom who had both political and economic freedom. In a
way I will describe below, Hayek saw both government
and markets as functioning better the more they were the
outcome of spontaneous development from the bottom up, with
nobody in charge. It took courage to criticize top-down
control after the scary calamities of the Depression, yet
Hayeks vision would be vindicated by subsequent events.
How many of us will show similar intellectual courage in
the midst of todays financial crash?

Hayek did not talk about it at the time, but his warnings
about the drift toward top-down planning were perhaps most
relevant of all in the so-called Third World. It is the
misfortune of the field called development economics that
it was born at the moment of maximum doubt about individual
liberty. As a result, economists conceived of development
from the beginningand to a frightening extent still
do todayas a top-down process run by development experts
operating on a blank slate.

The top-down experts would prove wrong time and time again,
yet the top-down view in development would prove curiously
impervious to failure, for reasons that I will also attempt
to describe.

In the beginning was the Big Push. Third World nations
in the 1940s and 1950s were thought to be in a poverty
trap in which poverty fed a vicious circle of excessive
population growth, poor health, illiteracy, lousy infrastructure,
and low savings. The answer, according to development economists,
such as Sir Arthur Lewis, was a huge injection of foreign
aidthe big pushto pay for critical
investments in all these areas at once. Some countries were
thought to be harder to develop than others. In the early
1960s, the World Bank ridiculed one resource-scarce country
as unlikely to attain even modest success in exports. Development
expert Gunnar Myrdal also raised the alarm at the same time
about another country, saying population growth was an explosive
problem. The name of the first country was South Korea.
The second was Singapore. Not that development experts were
always pessimistic: The World Bank said of another country
in 1958 that its potential compares favorably with
those of other countries in Southeast Asia. That country
was Burma.

Development experts did not do any better with overall
predictions than it did with those for particular countries.
Sir Arthur Lewis and others had a very particular model
of how aid raises growth that allows us to be precise about
how much growth they expected for a given amount of aid.
For the one-fourth of countries that received the most aid
over the last forty-five years, the prediction was that
per capita income would increase from about $500 per capita
in 1960 to over $5,000 per capita today. This tenfold increase
was more than achieved by a few low-aid countries that were
just as poor as the aid-receiving countries in 1960, such
as South Korea, which took advantage of market opportunities
created by the global boom in international trade after
World War II. So much for the poverty trap. Meanwhile, the
high-aid countries fell a little short of $5,000 per capita;
their income is still $500 today. So much for the Big Push.
When a theorys predictions fail, the theory is disproved.
What a tragedy that such failed ideas condemned so many
people to continuing poverty.

Hayek did not write much about development, but his defense
of markets and criticism of central planning was very relevant
to these debates. In a classic article in 1945, Hayek pointed
out that no top-down central planner can possibly have enough
information to allocate resources and make factories work.
A decentralized, bottom-up system allowed each individual
to use his or her own knowledge of hundreds of tiny local
factors and unexpected problems to make his or her own project
work, their actions coordinated with others by market prices
that signal to everyone which commodities are abundant and
which are scarce.

What Hayek correctly called a marvel was a
bottom-up system that nobody has to direct or even understand
in order for it to work. As Hayek said in 1945: those
who clamor for conscious direction . . . cannot
believe that anything which has evolved without design (and
even without our understanding it) should solve problems
which we should not be able to solve consciously.

There were development economists that got it right at
the time about individual liberty in development, such as
the South African economist Herbert Frankel and the British-Hungarian
economist P. T. Bauer. Unfortunately, there are better rewards
for bad ideas in development economics than for good ones.
Arthur Lewis and Gunnar Myrdal got Nobel prizes. P. T. Bauer
was ostracized as a heretic, and poor Herbert Frankel was
ignored and then forgotten altogether. I come before you
proudly aspiring to be this generations Herbert Frankel.

This is not to say that development economists werent
a bit capable of changing with events. In the 1980s, free-market
ideas finally started gaining acceptance among some development
economists in response to the failure of aid and the success
of the East Asian tigers. Yet, paradoxically, these same
development economists did not give up the top-down planning
mindset. Just reciting the words free markets
does not give you a free pass to be a top-down planner.
As the quote from Hayek just pointed out, markets evolve
from the bottom up without conscious design. IMF and World
Bank bureaucrats with little knowledge of local policies,
politics, or institutions imposed their own transitional
design as to how to jump to a free market in Africa, Latin
America, and the Middle East in the 1980s and 1990s.

These attempts became even more ludicrous with the fall
of the Berlin Wall and the imposition of shock therapy
on Eastern Europe and the former Soviet Union, a comprehensive
attempt by these same IMF/World Bank bureaucrats to take
a Communist economy to a capitalist one in one leap. Jeffrey
Sachs was the intellectual godfather of shock therapy. Again,
critics were a minority. Peter Murrell at the University
of Maryland and John McMillan at Stanford pointed to the
shocking hubris of the shock therapists. As McMillan summarized,
if we could have planned the reforms, then we could
have planned the economy.

GDP per capita growth was zero in Africa, Latin America,
and the Middle East in the 1980s and 1990s, and the republics
of the former Soviet Union experienced one of the worst
depressions in economic history. The backlash after the
failure of these so-called free market reforms,
imposed by foreigners, paved the way for the xenophobic,
anti-liberty figures like Chavez, Evo Morales, Mugabe, and
Putin.

Yet once again, being right got little reward: Murrell
and McMillan were ignored, while Jeffrey Sachs became a
celebrity economist despite the failure of shock therapy.
Jeffrey Sachs got even more fame for his top-down planning
approach when he re-discovered the fifty-year-old failed
ideas of the poverty trap and the Big Push from foreign
aid in the new millennium. These views resonated with many,
as individual freedom fell back into disfavor in development;
Sachs even gained the support of movie stars. Sachs cited
Hayeks support for his ideas, but unfortunately his
support came not from Friedrich Hayek but from Salma Hayek.

How come the top-down expert approach still dominates development
economics despite fifty years of failed predictions from
development experts? There are many reasons, but one that
I think is particularly interesting is that our brains are
hard-wired to believe in top-down planning. We see intentional
behavior by someone at the top even in a bottom-up spontaneous
order in which the outcomes are not the conscious goals
of anyone. Philosopher Daniel Dennett argues that human
evolution favored the intentionality way of
thinking. There was evolutionary payoff in seeing intentional
behavior in all living animals. When you saw a lion move,
you could get away if you understood that it intended to
eat you. When you saw a group of cavemen from the next cave
over approaching you with torches and clubs, you could defend
yourself more readily if you saw this as a group with a
specific agenda, such as killing your men and stealing your
women. Cavemen that saw intentional action everywhere survived.
Those who didnt perished.

So now perhaps we can understand statements from those
that attribute evil intent to spontaneous processes, such
as anti-globalization protesters who said in 2002 that corporate
leaders meet at posh gatherings in order to
chart the course of corporate globalization in the
name of private profits. Where there is inequality
in market economies, people too often believe that somebody
intended to make the poorest people poor. Where there is
spontaneous entrepreneurship that both creates new jobs
and destroys old jobs, the newly unemployed too often believe
that somebody conspired to take their job away. With our
caveman hard-wiring, it is difficult to understand that
nobody intends either the good outcomes or the bad outcomes.
Another Nobel laureate, Kenneth Arrow (someone who, unlike
Hayek, is not seen as a right-wing ideologue), said: [T]he
notion that through the workings of an entire system effects
may be very different from, and even opposed to, intentions
is surely the most important intellectual contribution that
economic thought has made to the general understanding of
social processes.

The idea of spontaneous order that is not designed or intended
by anyone has grown much more comprehensible in our day
than it was in Hayeks. We now realize that such diverse
areas as the Internet, language, biological evolution, social
networks, and even pedestrians walking on a sidewalk without
running into each other are spontaneous orders, with nobody
in charge. Seeing the absurdity of top-down planning in
these situations is to illustrate just how spontaneous they
are: How well do you think it would work to have a top-down
planner assign us our friends and our spouses? How well
would it work for a Manhattan Department of Walking to give
each of us, every morning, our precise paths on the sidewalks
so we wouldnt run into each other? But when you persist
in the caveman mindset of seeing outcomes as intended by
someone, even in bottom-up, spontaneous orders such as markets,
then you will always favor top-down, intentional action
by experts to try to improve the outcomes.

Hayek tried to counter this inbred bias by pointing out
just how much radical uncertainty there was in economic
life, which a top-down expert cannot possibly process. So
you need decentralized, independent searches for many types
of success by well-informed and highly motivated individuals.
He can say it better than I can:

The interaction of individuals, possessing different
knowledge and different views, is what constitutes the life
of thought. The growth of reason is a social process based
on the existence of such differences. . . . [I]ts results
cannot be predicted . . . . [W]e cannot know which views
will assist this growth and which will not.

and

Liberty is essential to leave room for the unforeseeable
and unpredictable; we want it because we have learned to
expect from it the opportunity of realizing many of our
aims. . . . [W]e trust the independent and competitive efforts
of many to induce the emergence of what we shall want when
we see it.

The way countries succeed in development is often by finding
a big hit in export markets. What will be the big hit is
impossible to foresee. Thats why you need Hayeks
independent and competitive efforts of many.
Who would have predicted that cut flowers in Kenya would
capture 40 percent of the European market for romantic men
bringing flowers home to their wives? You could say the
same about womens cotton suits in Fiji (42 percent
of the U.S. market), or floating docks in Nigeria
(84 percent of the Norwegian market), or electronic integrated
circuits in the Philippines (71 percent of the world market),
or regional jets in Brazil (Embraer now has 22 percent of
the world market). Egypts largest single manufacturing
export success, accounting for 30 percent of the total,
is bathroom ceramics, of which 93 percent goes to Italy.
Can you picture development experts telling the Egyptians,
The secret is just export toilets to Italy!?

Hayek correctly predicted that development would be unpredictable!
This may sound contradictory, but this is a genuinely testable
hypothesis, like the prediction of the efficient-markets
hypothesis that nobody can, year after year, predict the
stock market. Economic growth rates satisfy the unpredictability
hypothesis, not only the anecdotes above, but also research
conducted by me and others that finds that rapid economic
growth seldom persists. China and India are fast growers
now but were slow growers in the 1960s and 1970s; Brazil
and Cote dIvoire were fast growers in the 1960s and
1970s but have had slow growth since 1980. Statistical analysis
suggests rapid economic growth in the short run is determined
mainly by transitory factors that cannot be predicted. Even
a completely free market will randomly have high growth
during periods when entrepreneurs find a lot of big hits
and low growth when there is a stretch without big hits.

So the difference between successful bottom-up systems
that protect individual liberty and systems that restrict
liberty often cannot be seen that clearly in comparisons
of growth rates over limited periods, even over periods
as long as a decade. This difficulty is often exploited
by the critics of liberty, who can easily cite a counterexample
of an unfree country with rapid growth (China is the current
favorite). In fact, growth rates are so volatile that experts
can prove just about any theory of economic development
they want with a spurious example of a country with a temporarily
high-growth rate that also happens to have whatever economic
policy the expert likes. These arguments are the intellectual
equivalent of the Las Vegas gambler who attributes his streak
of good luck to the socks he was wearing at the time, and
will then keep wearing his increasingly foul socks in a
futile attempt to reproduce that luck.

The difference between free and unfree systems does
show up in long-run comparisons, such as in the level
of per capita income. The relevant fact about Chinas
long-run performance is that its per capita income is still
today ranked only 122nd in the world, behind Albania, Ecuador,
Gabon, Jamaica, and Suriname, at one-tenth of the level
of free America. Levels of per capita income are strongly
correlated with measures of economic and political liberty,
and statistical techniques suggest this correlation is causal:
liberty causes prosperity. Even North Korea has had periods
of high growth, but it would be hard to miss the argument
for liberty supplied by the vast differences today in per
capita income, health, and nutrition between free South
Koreans and enslaved North Koreans.

The last stab at finding employment by us development experts
is for us to concede that individual liberty is the best
system, but also to say that you need us to design the government
rules that make individual liberty possible. It is certainly
true that liberty needs government rules to protect private
property, to enforce contracts, to prevent cheating and
looting, and many other rules of good behavior that make
dealings between individuals possible. But it doesnt
follow that experts need to design government rules from
the top down. Hayeks last and possibly greatest insight
was that the government rules for a market economy are not
designed. They also evolve from the bottom up. As Hayek
put it: The value of freedom consists mainly in the
opportunity for the growth of the un-designed, and the beneficial
functioning of a free society rests largely on the existence
of such freely grown institutions.

How do institutions freely grow? Here I think economists
have gained further insights since Hayek wrote, although
we still have a lot to learn. We now have game theory, which
can describe a trust outcome in which each one of us agrees
to respect everyone elses property rights and contracts
in return for all of you to respect my property rights and
contracts. Anyone who cheats or steals can be punished through
social ostracism, which carries the added penalty of exclusion
from profitable contracts in the future with anyone. The
social norm will stabilize around respect for individual
liberty that treats individuals as both deserving of the
rewards of their own efforts and responsible for any costs
that they impose on the rest of us. Unfortunately, there
is also another equilibrium. If cheating and stealing start
out being widely accepted as normal, and each individual
expects to live off everybody else, then such a society
can get stuck in a distrust outcome and be unable to reach
the liberty norm. In fact, international differences in
the answer to a World Values Survey question on whether
individuals should take responsibility for themselves (about
as close as this questionnaire got to individual liberty)
are excellent predictors of which societies do in fact have
free-market and democratic institutions. So yes, of course,
you do need governments that pass laws to enforce rules,
but good governments just formalize the bottom-up reality
of social norms that respect liberty, which carry most of
the weight in enforcing the rules.

What explains different social norms across countries?
Here, frankly, neither Hayek nor todays researchers
have reached a completely satisfying answer. Historical
accidents probably matter: A recent study finds more distrust
between individuals today in regions of Africa where more
individuals were betrayed and sold into slavery during the
centuries of the slave trade. But Hayek also suggested that
rules and norms are themselves subject to a survival-of-the-fittest
evolutionary process (perhaps a slower one than we would
like). Individuals in poor societies without liberty who
see the connection between liberty and prosperity are going
to want liberty!

Now, here at last is a clear role for development experts.
They can try to speed up the evolutionary process by persuading
individuals around the world of how well a bottom-up system
works in the long run when people value individual liberty.

These benefits are not abstract: As the share of nations
with economic and/or political freedom has trended steadily
upward since 1970, the global poverty rate has fallen by
two-thirds. For the Kenyan employed exporting cut flowers
to Europe and the Egyptian employed exporting toilets to
Italy, free trade is not an abstraction.

We have similar examples of escaping poverty in our own
history. In 1927, a baby named Nathan was born in Americas
own Third World, West Virginia. His father, a low-paid lumber
inspector, died from tuberculosis when the boy was two years
old. His mother, named Dora, was left to support two sons
in West Virginia during the depths of the Great Depression.
If ever there was a poverty trap, this was one. But Dora
worked so hard that she was able to send Nathan to West
Virginia University. Nathan himself continued to work hard
at odd jobs until he could finance a return to West Virginia
University to attain a Ph.D. in biology. He left West Virginia
for a successful career as a professor of biology up north,
so that he could give his own children a middle-class standard
of living. I should know because I was one of those children;
Nathan is my father. I dedicate this Hayek award tonight
to my father, out of gratitude for how he realized the American
dream for our family.

With such inspirational examples, we owe it to the poor
everywhere to advocate the values of individual liberty
that offer the worlds last, best hope for ending poverty.
I will close with a paraphrase of my favorite liberty-loving
American politician, Abraham Lincoln:

It is for us the living to be dedicated here to the unfinished
work which they who came before us have thus far so nobly
advanced. It is for us to be here dedicated to the great
task remaining before usthat we here highly resolve
that our world shall have a new birth of freedomand
that development of the people, by the people, and for the
people, shall not perish from the earth.